Mea culpa - fat tax version

About two years ago, I co-authored a paper that was published in the journal Health Economics  with the title "When Do Fat Taxes Increase Consumer Welfare."  

I started work on that paper because I was troubled by the contradictory way in which economists had approached the analysis of fat taxes.  One the one hand, economists estimated the effects of fat taxes by using elasticities of demand that were derived from a rational consumer-utility maximizing model.  In this kind of conceptual model, a tax (or a price increase) cannot make a consumer better off.  However, on the other hand, economists were publishing these papers with the premise that somehow the tax could make people better off.   In the paper, we tried to think about an approach for reconciling these two stances by asking whether a tax could make people better off if we make the reasonable assumption that people also care about (and consider) weight or health effects when choosing the quantity and type of food to buy.   

We had argued that in this situation, it was possible but empirically unlikely a tax could make people better off.  Enter Professor Neill, who wrote a comment on our work, saying "no" - it is concetually impossible for a fat tax to increase consumers' well-being in a "standard" economic model of the consumer.  Here are the first sentences of our forthcoming response to Dr. Neill:

We are flabbergasted at how such a fundamental lesson of mathematical economics escaped our attention, but Professor Neill is right and we were wrong. We apologize. 

Neill pointed out, embarrassingly to us, what should be obvious to any serious student of economics.  A tax is akin to reducing someone's income.  No one is better off with less income.  Even if one wants to weight less, they don't need a tax to do it.  A consumer can achieve a lower weight at current prices and re-allocate their income toward other non-weight-increasing goods and achieve a higher level of satisfaction.  

So, how do economist justify fat taxes?  One approach is to claim that obesity is an externality - that my food choices impose a cost on you (via Medicare/Medicaid) and thus a tax can force me to properly consider those costs.  However, in a paper a couple years ago, Bhattacharya and Sood dismantled the validity of that argument (although it is not well understood and continues to be debated).  

Another response is that the "rational consumer utility maximization" model is incorrect.  This "behavioral economics" approach posits that people fail to properly account for their future well-being and that a tax can force people to make decisions today that their future selves will ultimately find beneficial.  The precise mechanism for this welfare improvement is rarely laid out with any precision.      

In our reply to Neill, we tried to sketch out a behavioral-economics type model to see when a fat tax might be justified on those grounds.  Here is our conclusion:

under this sort of behavioral economics framework, where people naively or myopically optimize utility without considering future weight effects, it is possible to imagine situations where raising prices might increase ultimate experienced welfare. However, this condition occurs only when price is very high and falls in the range where consumption would take place only because people are ignoring the ultimate health impacts; at lower prices, a ‘fat tax’ would only lower welfare.